We analyze corporate fraud in a model where managers have superior information but, due to private benefits from empire building, are biased against liquidation. This may induce them to misreport information and even bribe auditors when liquidation would be value-increasing. To restrain fraud, shareholders optimally choose auditing quality and the performance sensitivity of managerial pay, taking into account external corporate governance and auditing regulation. For given managerial pay, it is optimal to rely on auditing when external governance is in an intermediate range. When both auditing and managerial incentive pay are used, worse external governance must be balanced by heavier reliance on both of these incentive mechanisms. In designing managerial pay, equity can improve managerial incentives while options worsen them.
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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number
203.
Find related papers by JEL classification: G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation K22 - Law and Economics - - Regulation and Business Law - - - Corporation and Securities Law M42 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - Auditing
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Giovanni Immordino & Marco Pagano, 2005.
"Optimal Regulation of Auditing,"
CSEF Working Papers
133, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 May 2007.
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Other versions:
Paul Povel & Rajdeep Singh & Andrew Winton, 2007.
"Booms, Busts, and Fraud,"
Review of Financial Studies,
Oxford University Press for Society for Financial Studies, vol. 20(4), pages 1219-1254.
[Downloadable!] (restricted)
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Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Giovanni Immordino & Marco Pagano, 2005.
"Optimal Regulation of Auditing,"
CSEF Working Papers
133, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 May 2007.
[Downloadable!]